Posted by Jeffrey Brown on Aug 20, 2013

Earlier this year, I co-authored a proposal with four colleagues to reform the Illinois State Universities Retirement System. My motivation for doing so was quite simple: the fiscal crisis facing the state of Illinois is very real, “doing nothing” is not an option, the politicians seemed to be making little headway on a solution, and the ideas that were under consideration appeared to be driven far more by ideology than by concern about good retirement policy and good fiscal policy. Given that I have spent the past 15 years of my life developing academic, policy and practical expertise on issues related to retirement income security, I thought I owed it to Illinois taxpayers to make a serious attempt to bring some balanced, centrist thinking into the discussion. My four co-authors brought exceptional expertise in areas of university administration, benefits design, state and local public finance, and other highly relevant topics. Together, we proposed six specific reforms to the SURS system.

Our “Six Simple Steps” proposal was subsequently endorsed by the Presidents and Chancellors of all of the public universities in Illinois. It has also received favorable feedback from many participants and retirees. Over the summer, our proposal gained serious political traction when the bicameral, bipartisan pension committee of the Illinois General Assembly began to treat it as a leading possibility for breaking through the political logjam that had stifled prior attempts at reform.

Now that our proposal – which is sometimes referred to by others as the “Universities Plan” or the “IGPA Plan” – has gained traction, the political knives are coming out on both sides of the ideological divide. This is not surprising: under our proposal, faculty are being asked to contribute more, retirees are being asked to receive less, the universities are being asked to take on greater financial responsibility for future costs, and the state is being put on the hook for paying down the enormous unfunded liability. There is plenty of pain to go around.

We did not cause the pain, of course. The pain was caused by many generations Illinois General Assembly members who failed to behave with even a modicum of fiscal responsibility. We are just asking legislators, participants, retirees and taxpayers to be honest about the severity of the problem and to take meaningful steps to stop the fiscal bleeding. But, in a highly politicized environment, with billions of dollars at stake, I am not at all surprised that ideologues and interest groups are pulling out their knives and trying to cut down our proposal.

So allow me to let you in on a little secret – I don’t love our proposal either. A few aspects of it leave a bad taste in my mouth, in the same way that some life-saving medicines do. However, I honestly consider to be the best – by far – of a wide range of distasteful options.

Let’s be honest: If I lived in a state where the state government was not dysfunctional, where we did not have strictly binding constitutional constraints, and where we could draw up our pension system from a relatively clean slate, I would NOT design a system exactly like the one we are proposing. Rather, I would commit the state to a credible funding path; I would raise the normal retirement age to be in line with Social Security; I would fully index benefits to inflation and, if needed, pay for it through downward adjustments to initial benefits; and I would align incentives by making the entities responsible for hiring decisions (e.g., the universities) also be responsible for paying the full benefit costs associated with those hiring decisions. While I am dreaming, I would also require the state to use accounting rules that transparently communicated the real economic cost of pensions, rather than hiding the true costs behind intellectually flawed government accounting standards. Then again, if I lived in such an ideal world, we probably would not be facing the worst pension funding crisis of any state in the nation, and our proposal would have been unnecessary in the first place.

But we, the residents of Illinois, do not live in such a world. Rather, we live in a state where for many decades our political leaders have failed to make good on the state’s most basic financial obligations. As a result, the time has come for us to take our fiscal medicine: everyone must make sacrifices. Unfortunately, the very constitutional protections that were intended to protect retirees now prevent us from enacting the most sensible reforms (such as raising the retirement age, which nearly every serious analyst agrees is a good idea): instead, we are forced to use second-best policy tools (such as reducing COLAs) simply because they have a better chance of passing constitutional challenge. And we live in a state where after several unproductive years of debate, various powerful politicians have made it crystal clear that certain types of reform are political “must haves” and others are “cannot haves,” a situation that further narrows the realm of politically feasible options.

With these and other painful realities in mind, my colleagues and I set out to design a plan that made the best of a truly terrible situation. We settled on a plan that:

Has a reasonable chance (although not guaranteed) of being deemed constitutional;

Has a reasonable chance of being politically feasible (as demonstrated by the recent support the plan has received from the bicameral bipartisan pension commission);

Will substantially improve the state’s long-term fiscal situation;

Preserves a smaller defined benefit (DB) element to recognize that many public workers in Illinois are not in Social Security, but also creates a defined contribution (DC) account, in an attempt to balance the various strengths and weaknesses of the two types of plans and create a better system than the Tier II system in place for new employees;

Improves the retirement security of new employees through more favorable vesting rules (that are also more closely aligned with private sector practice);

Provides real – if imperfect – inflation protection by linking increases to the CPI, rather than providing an arbitrary annual nominal increase that leads to enormous fluctuations in retirees’ real standards of living;

Substantially increases the likelihood that the state will begin to pay down the unfunded liability, both by reducing the state’s share of future costs and by providing the stakeholders with a legal right to enforce state funding;

Appropriately aligns incentives so that universities bear the full cost of their hiring decisions;

Suggests many other features that attempt to bring some rationality and transparency to a complex and opaque system (such as reducing the hidden subsidy provided via a financially inappropriately high Effective Rate of Interest);

In recent weeks, once it became clear our plan was gaining political traction, two different analyses came out criticizing our Six Step Plan. There are two things to note about these criticisms:

Second, the criticisms are striking in the extent to which they are mirror-images, taking precisely opposing views to one another. The first of these critiques was offered by the Illinois Policy Institute. They criticize our plan for preserving the DB system, not moving fully to a DC world, not eliminating COLAs, not saving enough money, and taking too long to phase in the changes. The second of these critiques is by a researcher at University of Illinois at Chicago and the head of Keystone Research Center. They criticize our plan for not preserving the DB system in its entirety, for suggesting the introduction of a DC element, for partially reducing COLAs, for asking the state to pay down the unfunded liability too quickly and for cutting benefits too much. And, in an amazing feat of mental gymnastics, they also suggest that by reducing spending the plan will somehow raise costs to the state.

To the extent we were trying to design a proposal in the “sensible center” of this debate, I will take these completely offsetting criticisms as confirmation that we are on the right track.

Here is a brief table summarizing how the two critiques often negate each other, in their own words (followed by my parenthetic and italicized remarks summarizing their view in my own words).

Our Proposal

Illinois Policy Institute

KeyStone Research

COLA: Switch from 3% automatic annual increase to 50% of CPI

“The IGPA plan fails to achieve the savings necessary to reform Illinois’ pension system by only partially reducing cost-of-living adjustments, or COLAs”

(in other words, we should completely eliminate the COLA)

“It would undermine the retirement security of Illinois public‐sector retirees, and especially harm those who live a long retirement”

(in other words, we should make no changes to the COLA)

Hybrid DB/DC system for new employees

“The IGPA plan takes reform in the wrong direction by maintaining the defined benefit pension system for current workers”

(in other words, we should totally eliminate the DB and have only a DC)

The plan would “be as bad as or worse than Tier 2 because of the

reduction in the defined benefit portion of the plan from a 2.2% multiplier to 1.5%.” and “DC plans are less cost effective”

(In other words, we should totally preserve the existing DB and not have any DC)

Force the state to pay down the unfunded liability

“this plan allows the pension systems and their members to take legal action to compel the state to make the pension payment. Pension guarantees similar to this plan prioritize pension payments above all other government services, jeopardizing funding for those who rely on it the most.”

(in other words, we should not provide additional tools to force states to pay down the unfunded liability)

“This could be coupled with extending the time

taken to get to 100% funding.”

(In other words, we should not actually reduce benefits, but simply stretch the payments over a longer period of time)

Reduces state’s overall cost as much or more than other proposals

“Savings this small not only fail to solve the problem, but will also require lawmakers to revisit Illinois’ pension crisis again in just a few short years.”

(In other words, we simply did not slam workers and retirees enough)

“the Universities proposal could result in higher costs to taxpayers”

(In other words, even though they think we are cutting benefits too much, they falsely claim that somehow this risks increasing costs)

I can understand why those who advocate for the smallest possible government would be disappointed with a plan that does not squeeze out even more savings from the pockets of public sector workers. I can also understand why some public sector workers and retirees would oppose any benefit reduction. But such extreme views, while potentially useful for advocacy purposes, do not make for good public policy. The above comparison make it self-evident that these two critiques are attempts to bolster opposing untenable positions: the Illinois Policy Institute would prefer that we decimate retirement security, and the KeyStone group naively acts as if we can solve this crisis without meaningful changes to benefits. Supporters of both positions will be disappointed with any realistic proposal that actually solves Illinois’ pension problem while preserving retirement security of public workers.

You may not like our plan. As I noted earlier, I am not in love with it either. But I still think it is the best idea out there so far. Very little in the Illinois Policy Institute or Keystone critiques alters my view with the exception of continuing the existing Self-Managed Plan as a voluntary option for some new employees, as suggested by the Illinois Policy Institute, although I do not think it is the best choice for the median employee.

I am totally open to the possibility that better ideas than ours may still be out there – and if either of these two groups (or any other group or individual) have substantive suggestions that are fiscally responsible AND politically feasible AND constitutional AND not unduly harmful to public employees, I would love to hear them. So far, however, I continue to believe our Six Step proposal is the most serious proposal on the table.

Prof. Jeffrey R. Brown, 8/19/2013

(Author’s note: the opinions expressed here are those of the author – Prof. Jeffrey Brown – alone, and do not necessarily represent the views of any of my co-authors or the University of Illinois.)